Essays in international finance

In this dissertation, I offer two essays on international finance with particular attention to the sovereign debt maturity structure along with the dilution problem and interbank credit crisis that propagates from one country to another. First one is a study on the effect of varying maturity structure on the default probabilities and prices of bonds with and without the dilution problem while the later one develops a financially integrated two-country model with moral hazard and asymmetric information in the banking sector of the economy where endogenously determined interest rates in the economy may cause interbank credit freeze due to overaccumulation of assets and/or a mild productivity shock. In “Sovereign Debt Maturity Structure and Dilution”, I investigate different maturity structure of sovereign bonds; starting from short-term bonds only. I assume that the sovereign can issue only short-term bonds or long-term bonds, and then extended the work with both short- and long-term bonds. Finally, I also investigate what happens to the default probabilities and the prices of bonds if there is a compensation covenant in the sovereign debt contracts for the long-term bondholders to mitigate the dilution problem.The finding is that the maturity structure of sovereign bonds plays an important role in determining the default probabilities and bond prices. Sovereign can improve these by issuing both type of bonds. Moreover, inclusion of the compensation covenant mitigates the dilution problem of sovereign debt in a larger scale when the maturity of long-term bonds is sufficiently high. In “Interbank Liquidity Crisis and International Contagion”, we develop a two-country model with integration in different ways. We investigate integration in terms of labor, deposit, and capital mobility both individually and in different combination. Privately known intermediation skills of banks make them heterogeneous and gives rise to the interbank market. When countries are integrated through the banking channel, different corporate lending rates also give rise to different deposit rates and capital supply but the same inter-bank lending rate. Overaccumulation of assets causes excessive supply of funds during a mild negative productivity shock and creates an interbank market credit freeze in one country which propagates to another country through the interbank lending market.